FOMC Recap Doves flying high as Fed drops two dots

As we noted in yesterday’s FOMC Preview report, any Fed fireworks wouldn’t come from the monetary policy decision per se, but rather how today’s meeting shaped the conversation around the timing of the next rate hike in the coming months. As of writing in the midst of Yellen’s presser, it’s been the monetary policy doves who are flying high, rather than the hawks.

Let’s get right into the headlines to see what’s driving markets [emphasis mine]:

• FED LEAVES RATES UNCHANGED AT 0.25%-0.5% AS EXPECTED
• FED SAYS GLOBAL ECONOMIC DEVELOPMENTS CONTINUE TO POSE RISKS
• FED MEDIAN FORECAST IMPLIES TWO 2016 RATE HIKES VS FOUR IN DEC
• FED FORECASTS SHOW SHALLOWER PACE OF RATE RISES IN 2017, 2018
• FED: MKT-BASED INFLATION COMPENSATION MEASURES REMAIN LOW
• FED SAYS RANGE OF DATA SHOW MORE STRENGTH IN LABOR MARKET
• FED: ECONOMY EXPECTED TO WARRANT ONLY GRADUAL RATE INCREASES
• FED: ECONOMIC ACTIVITY MODERATE DESPITE GLOBAL DEVELOPMENTS

Focusing on the statement first, the changes were relatively minor relative to January’s release. For what it’s worth, the changes to the statement appear to reflect a more cautious Fed, despite the recent improvements in financial conditions (read: rising stocks). Crucially, the central bank re-introduced comments about "global economic developments," a blurb suggests that policymakers are hesitant to raise interest rates amidst economic slowdowns in Europe and China.

This caution was borne out in the accompanying summary of economic projections, including the now infamous "dot chart." Relative to the last big Fed meeting in December, participants revised down their year-end expectations for economic growth and inflation (core PCE) slightly, while also revising down the longer-run forecast for the unemployment rate.

While these updates represented a minor setback for the hawks, the true knockout blow came from the "dot chart" of interest rate expectations. From a median year-end interest rate expectation of 1.25-1.5% in January (representing four more interest rate hikes), the median FOMC policymaker now expects interest rates to be in the 0.75-1.00% range at the end of the year (representing only two more interest rate hikes). After dramatically revising down its interest rate "liftoff" path, it would be extremely hard for the Fed to subsequently go on to raise interest rates three times over the remainder of the year; in other words, two interest rate hikes are the absolute maximum that hawks can hope for this year, and if Fed Funds futures traders are right, a single rate hike is far more likely.

Thus far in her press conference, Dr. Yellen has tried to downplay the changes to the Fed’s statement and projections, stating that the "outlook hasn’t changed much since December." It’s worth watching to see if she’ll continue to sing from the dovish hymn sheet, but barring a Draghi-esque reversal, it looks like Fed doves are on track to take the day.

Market reaction

The market’s reaction thus far supports our dovish read of today’s Fed festivities. The US dollar has been a major casualty of traders pushing back their interest rate hike expectations, with EUR/USD rocking to 1.12 and USD/JPY dipping below the 113.00 level already. Yields on the benchmark 10-year bond are falling by 3bps on the day to 1.94%, and the 2-year yield (which more closely follows interest rate expectations ) is off by more than 8bps to 0.89%. The big beneficiaries of the announcement (beyond non-dollar currencies) have been US equities, with major indices trading up by about 0.5% on the day.

We wouldn’t be surprised to see these initial moves extend into the close and Asian session as traders continue to digest the implications of the Fed’s dovish shift.

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